The dollar is likely to continue weakening, particularly versus the euro and sterling, as the Federa...
The dollar is likely to continue weakening, particularly versus the euro and sterling, as the Federal Reserve tries to reflate the US economy.
A falling dollar is generally seen as positive for US industry as it increases export competitiveness and reduces import competition in a world of falling trade volumes, thereby boosting US corporate profits. The effect this will have on European and Asian economies may be less favourable, however.
The impact of a weaker dollar on eurozone countries is broadly expected to be negative and is leading some fund managers to favour US equities over their European counterparts on a currency-hedged basis.
Ian Williams, head of fixed interest broking at Durlacher, notes the Fed has vowed to buy in its longer-dated debt and sell short-dated Treasuries to the banks if necessary, effectively printing money in a bid to stave off deflation.
In other words, the US will go to any lengths to avoid deflation regardless of the impact such fiscal measures have on the rest of the world, he adds.
'In effect, a weaker dollar is a classic beggar-thy-neighbour tactic as it exports any recession to the eurozone through a rise in the euro, making exports from France and Germany expensive,' Williams notes.
'As long as the US authorities are prepared to print any amount of money to avoid recession, the dollar will remain a weak currency. But the US economy will not suffer deflation in the same way as the Europeans, whose industries are more dependent on exports than the US is on imports.'
Williams expects US equities to outperform French and German equities, although the reverse is anticipated for bonds due to the greater risk of deflation in Germany.
The picture is less clear in Asia, where strong expectations of a declining dollar reflating the region have been tempered of late by moderate trade-weighted currency depreciation in Asia on the back of the weaker dollar.
Jim O'Neill, an economist at Goldman Sachs, notes since the dollar embarked on its current decline in early 2002, the non-Japan Asia trade-weighted index has fallen 5%, compared to 30% between 1985 and 1987, the last significant period of dollar depreciation.
While a more substantial decline for Asia's trade-weighted index would set the conditions for a strong bull run, as in the mid-1980s, O'Neill believes this is unlikely.
'What matters for Asia is not a cheaper US dollar per se but, ultimately, firming prospects of a near-term pick-up in global demand and the increased pricing power this would confer on Asian exports,' he says. 'We see both as largely a 2004 story.'
Active intervention by the Bank of Japan has ensured the yen has not appreciated markedly against the dollar, thereby retaining its competitiveness against other currencies in the region.
Moreover, O'Neill believes the reluctance of Japanese and Asian authorities to allow their respective currencies to appreciate versus the dollar has led to greater upward pressure on the euro.
China has been one of the chief beneficiaries of the weakening dollar, O'Neill says, owing to the renminbi's quasi-peg to the US currency.
US exports becoming more competitive.
Asia benefiting from cheaper dollar.
Fed dedicated to avoiding deflation.
Competitiveness of eurozone eroded.
Chinese renminbi remains inflexible.
US deflation could be exported to eurozone.
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